Is the stock market really the place to be?

QUESTION: I have been hearing a lot about how people made money in the stock market and how the Philippine Stock Exchange Composite Index (PSEi) has been reaching new highs. Is this now the best place to invest in the country?—EnRich training participant

Answer: I have been in the fund management industry for over 25 years and I have gone through a good number of crisis and recovery periods.

Naturally, people are ecstatic about the high returns, especially in the recent past. Unfortunately, these tend to mask the volatility or risk that they need to take into account. But before I scare you away from stock investing, let’s review some hard numbers first.

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If you look at the historical compounded annual returns of the PSEi, the volatility of performance pops out.

For the 1-, 3-, 5-, 10- and 25-year periods as of end 2012, the PSEi’s compounded annual returns were 33 percent, 24 percent, 10 percent, 19 percent and 8 percent, respectively. While three of the periods under review showed returns of at least 19 percent, the two other periods, particularly the 5- and 25-year periods showed compounded annual returns of no more than 10 percent.

Focusing on the bigger picture, the PSEi was volatile within a long-term sideways movement from 1993 to 2008. In this period alone, global financial markets went through the Asian financial crisis, the dotcom crash and the US housing bubble and debt crises.

The PSEi was pulled down and propelled up by cycles of crisis and recovery with an obvious impact on returns.

For example, the 5-year return was meager because of a high base in 2007. The PSEi was at a high point in 2007 as investors around the world were still enjoying the recovery momentum from the end of the dotcom crisis of 2002. In fact, the PSEi was at the highest point of its long sideways movement in 2007.

Little did investors know that the following year would be tumultuous, to say the least.

In any case, despite the yearend PSEi level of over 5,800 in 2012, the stock market was able to produce an annual compounded return of only 10 percent for the 5-year period precisely because of the high base in 2007.

On the other hand, 2002 displayed one of the lowest composite index levels in the PSEi’s long sideways movement. With a hot stock market in 2012 and a low base year in 2002, the PSEi easily produced an impressive compounded annual return of 19 percent for the 10-year period.

The question is which long-term return is more sustainable?

Given recent developments in the stock market, the PSEi’s 5-year compounded annual return of 10 percent appears to be more reflective of a sustainable long-term return from passive investing. By passive, I mean merely mimicking the portfolio composition of the PSEi. Higher portfolio returns can still be made but only if you “play the volatility” through active trading, which is proven by the 5-year compounded annual returns of non-equity index mutual funds and UITFs.

The recent high returns of the PSEi will eventually be tempered by its high P/E multiple of 20.9 x. In and of itself, that P/E multiple is high. But it becomes starkly expensive when compared to those of Thailand (18.1 x), Indonesia (17.9 x), Singapore (10.3 x), Hong Kong (11.9 x) and China (15.3 x for Shanghai B shares). Corporate earnings in the Philippines would need a significant upward re-rating to bring the PSEi’s P/E multiple to attractive levels.

Now let’s compare the PSEi’s performance to that of a benchmark, say the 364-day Treasury bill (T-bill). For the 1-, 3-, 5-, 10- and 25-year periods as of end 2012, the 364-day T-bill’s compounded annual returns were 1 percent, 2 percent, 4 percent, 6 percent and 11 percent, respectively.

Despite its volatility, the PSEi was able to outperform the 364-day T-bill over all but the longest period under review. But what accounts for the underperformance of the PSEi’s 25-year period return?

Remember that in the early 1990s, the Philippines still had exceedingly high interest rates. The 364-day T-bill fetched 26.1 percent in 1990 and 23.9 percent in 1991. In addition, the Philippine stock market did not enjoy as much trading activity then as it did in 2012.

But given the country’s much more stable economic, social and political environment today, it is difficult to imagine the Philippines going through another regime of exceedingly high interest rates or tepid stock market trading.

Therefore, if you are after long-term investing, then the stock market is the place to be for you. And to manage the risk while going after high returns, do periodic investing in an actively traded pooled fund.

If you want assistance with investing as well as with personal finance in general, download Ya!man, the country’s first free personal finance mobile app, from www.personalfinance.ph. You may also want to attend the public runs of the EnRich CD-RW personal finance training. For details, please call 2161541 or 3593094. You may also e-mail info@personalfinance.ph.

(Efren Ll. Cruz is a Registered Financial Planner of RFP Philippines. For questions pls SMS to 0917-5050709 or e-mail to efren@personalfinance.ph. To learn how to become RFP, attend FREE personal finance talk on Feb 21 7pm PSE Center. Email at info@rfp.ph)